Roth IRA Basics

Roth, Roth, Roth. Everyone, it seems is talking about Roth, and if you haven’t, rest assured – you will. Over the next few months, you will probably hear a lot about Roth IRAs because of a change in the rules that will take effect in 2010 regarding converting a traditional IRA into a Roth IRA. That subject is just a little too complicated for most people, so let’s take a quick look at some of the fundamentals.

Roth Basics

If saving for your retirement is one of your financial goals (and it should be), you might want to consider investing in a Roth IRA. You should know that some people earn too much to qualify; here are the limitations:

In general, if you file as a single, you can make the full contribution provided that you earn no more than $105,000; if you’re married and file a joint return, that maximum is $166,000. It’s actually a bit more complicated than that, but if you’re interested in learning the nitty gritty, here is a link explaining how to calculate the amount you can earn and still contribute to a Roth IRA.

Investment Choices

As with a traditional IRA, you can invest in a number of things: Certificates of Deposit, stocks, bonds, mutual funds, etc.

Advantages

With a Roth, all earnings on your investments escape taxation completely. This is unique. All other investment vehicles are either taxed currently or tax-deferred. By tax-deferred, I mean that you don’t pay any taxes until you take the money out. Examples of tax-deferred investments are 401(k)s and 403(b)s, as well as traditional IRAs.

Other benefits of a Roth IRA include avoiding the early distribution penalty on certain withdrawals and eliminating the requirement to take minimum distributions after age 70½.

Disadvantages

So what’s the catch? The primary disadvantage of a Roth IRA is that you don’t get a tax deduction when you contribute to it, as you do with other retirement options. Your personal situation will drive what is more important, tax-free growth or a current tax deduction. But that decision to go with a Roth will also depend on the assumptions you make about what your tax bracket may be when you retire.

Another disadvantage of a Roth, albeit a minor one, is that you have to go out of your way to use it. What I mean by that is you have to actually open an account with a bank, brokerage firm or mutual fund. With a 401(k) or 403(b), you just pen your John Hancock to some forms at work and you’re good to go.

Aside from the (in)convenience aspect, psychologically it is easier to save though an employer sponsored plan, simply because you never see the money; it comes right out of your paycheck. And, of course, many employers match your contribution either in full or in part, which you ordinarily wouldn’t want to miss out on. That is, after all, found money.

Limits

What’s the maximum you can contribute to a Roth IRA? The same amount as the traditional IRA. For 2009, it’s $5,000 if you’re younger than 50 years old; otherwise, it’s $6,000, and both spouses can make contributions to a Roth. You should be aware that contributions are a “use it or lose it” proposition; in other words, if you fail to take advantage of this year’s contribution, you can’t do it retroactively.

In general, a Roth IRA is a very smart choice in saving for retirement for many people. To make the right decision for you, discuss the question with your financial planner or accountant.

Comments

2 Responses to “Roth IRA Basics”

Matthew Raden on
June 23rd, 2009 11:00 am

What are the advantages and disadvantages of investing in a 403b vs. a Roth IRA? From what I understand, with the former, you get a tax deduction up-front but have to pay taxes on the back-end whereas with a Roth you get no deduction on contributions up-front but pay no taxes on the back-end.

Yes the main difference between a 403(b) and a Roth IRA is the tax treatment. However, when it comes to 403(b) options, there is another factor – costs. Frequently the choices within a 403(b) plan are very expensive, and the fees may be hidden. So it depends on the choices that are available to you within your 403(b) plan.

Roger

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